Oat Soda Market Analysis

Today more than ever, mass production seems to be a way of life and with that comes colossal factories. Most factories take advantage of both economies of scale and economies of scope to reduce costs and increase output, ie become more productive.

Each industry has a unique cost structure which basically means that every industry incurs a different set of costs. The textile industry is extremely labor-intensive so the set of costs for a textile factory would include a high labor component whereas a beer factory might have a high cost of capital component due to the types of machines used. So given a certain cost structure, is there such thing as an optimal factory size? Of course there is! And there are many different ways economists can find this "optimum" meaning most efficient but the easiest way was discovered by George Stigler in 1986 in his paper "Barriers to Entry, Economies of Scale, and Firm Size." His theory stated that if a factory is efficient, in the long run all other factories (with identical cost structures) should approach the size of that efficient factory. This means that if an industry's factories were broken down by size (as seen below), a reduction in the number of factories producing at the inefficient levels (normally very small and very large amounts) would occur over time.

This is what happened in the beer industry between 1959 and 1979.

Elzinga (1986)

You can see that beer factories which chose to produce under or at 2 million barrels decreased over time. To take an example, the smallest factories which produced 0-25 thousand barrels a year went from having 11 such factories in 1959 to just 2 in 1979. Stigler would say that a factory producing 0-25 thousand barrels a year is inefficient. On the other end of the spectrum, a factory producing over 4 million barrels a year is extremely efficient since the number of factories at that capacity increased from 2 in 1959 to 20 in 1979.

Did the inefficient factories close up shop within the 20 years between 1959 and 1979? Most likely not. The smaller factories might have realized that they were not taking advantage of economies of scale (spreading large fixed costs over increasing amounts of quantity) and increased their capacity, adding to the numbers of bigger breweries. This indicates that before the mid-1980's, economies of scale played a major role in the production of beer and that firms realized the maximum benefit of economies of scale the larger they were.

The number of breweries decreased from 465 in 1947 to 80 in 1983; an 82% decrease. This trend started after Prohibition when the drinking environment had been radically changed. Prior to Prohibition, establishments were allowed to make and sell their own alcohol and therefore, there existed many small brewpubs and breweries that owned bars, 1566 in fact (nearly the number there are today!). But after Prohibition, alcohol manufacturers were prohibited from owning bars and/or retail outlets. Therefore, the small breweries and brewpubs that had existed prior to Prohibition exited the market due to dramatically reduced profits that had previously come from their retail operations. The larger breweries took advantage of a market in which most rivals had exited.

Today there are 1,599 breweries in the US; nearly 20 times the number of breweries in 1983 and 3.5 times of that which existed at the peak in 1947. One might simply say that Americans have increased their preference for beer but an economist might choose to explain it in a different light.

First, government lifted the ban on breweries having retail operations, creating more opportunities for smaller breweries, as seen prior to Prohibition. Most economists will agree, less regulation creates more opportunity for innovation, profit maximization, and reduces barriers to enter a market.

Secondly, a new technology was created in the late 80's. That innovation was the unheard of concept of competing on the characteristics of the beer rather than the price. Into the 80's, beer producers were still competing on price and general taste but coming into the 90's, microbreweries began to pop up with boutique beers with interesting flavors that hadn't been seen for many decades. The price charged was not comparable to those of the large breweries but this didn't matter - it was an entirely different product. Today, microbreweries only control 5-7% of the beer market, which if you live in Oregon is hard to imagine that statistic being so small.

So does the emergence of microbreweries debunk the conclusion that breweries are more efficient the larger they are? Definitely not! Economies of scale refers to cost savings that occur due to increased production, ie less inputs making more outputs! Since the cost structure for craft breweries is very different from that of large non-craft breweries, both types could very well be operating at minimum cost and be benefiting from economies of scale.

What's in a Statistic

Consumer spending - a major indicator as to the health of the economy and also of consumer's expectations - remained "flat" in April, rising only 0.4%. March saw a rise of 2.2% month-over-month, which had economists forecasting equally large increases for the month of April. But neither number is indicative as to what's happening in the economy without proper analysis.

ERRORS:
If you care about consumer spending or any statistic for pure conversational purposes, you may want to consider the errors reported for each statistic, which are found in the original issued report. Every statistic has an error margin and economists can say with 95% certainty that the value reported is between two values. For instance, April's consumer spending increase of 0.4% had a "confidence interval" between -0.1% and 0.9% meaning that economists are 95% certain that the number reported is somewhere in that range. Theoretically, we could have had a decrease of 0.1% or an increase of nearly 1%. What this really means is that the reported statistic is no different from zero.

UNDERLYING ANALYSIS:
Consumer spending normally increases as personal income increases. Both statistics increased 0.4% (theoretically zero) in April. In the same month, the savings rate rose 3.6% indicating that instead of spending, consumers are saving. And for some reason, the media makes this sound scary.

What's really going on is consumers are being careful; they're re-establishing their savings base, something many lost during months of unemployment or furlow. What this means today is that companies might hold off on increased employment and capital spending. What this means in the long run is that consumers are voluntarily creating a stronger, healthier, and safer economy by learning to live within their means. Don't forget, for the housing market to see increased buyers, there must be saved money out there somewhere and that's exactly what people are now doing.

More Regulations?

Congratulations USA, you can now change your name to China. I'm referring to government regulation restricting private broadband companies from pricing their products. When I first read the article in the WSJ about a government effort to regulate the Internet I was shocked - how could this happen in the US? But after reading the article I was still shocked, but for a very different reason.



My first impression was that the regulation would concern content but that misconception was quickly stymied. As I read on I learned that what in fact the government is proposing is "net neutrality," which is purposefully vague and P.C.-sounding and is sure to confuse and convince many who refuse to read between the lines. The issue being debated is the current pricing schedule used by most broadband companies.



Broadband customers have a choice; for those that use the Internet for surfing the web and emailing they can opt to purchase the low-speed option for which they pay less. For those that like to download mega files and stream video constantly, they have the choice to pay more and get more speed. So far so good.

The issue here is that both customers are using the same cable with the same potential speed but for broadband companies to target multiple markets, they must offer diversified products. But to do this, broadband companies need to make their one product, a high-speed cable, into multiple products by purposefully slowing the Internet to those customers that opt for the basic package.

This is where the government comes in. They spout "net neutrality" and how everyone should have equal access (read: speed) to Internet. Therefore, my grandma who pays 19.99 for basic high-speed cable should have the same access that large corporations receive who pay thousands of dollars in order for their firm to have access to the fastest Internet possible.

It is basic economics that people like choice, people like diversified products, and that they are willing to pay more to get exactly what they want. By regulating the market, the government will create a market with a one-size-fits-all product.

Last week I was invited to attend a membership breakfast for MetroMultifamily; a local organization for businesses that manage multifamily housing. At the breakfast were many great speakers but maybe some with misguided opinions.

The consensus of all the speakers was summed up spectacularly by the sponsor of the event, Servicemaster Clean, who said "We're still drowning but we're downing closer to shore." But there seemed to be a feeling, and a quite optimistic one at that, that the Portland rental market would be tightening up drastically in the semi-near future. This belief was supported by the seemingly larger market of renters brought on by the effects of the recession. Many homeowners switched to renters out of necessity and now the question on every manager's lips is, Will they stay renters or go back to owning.

Many of the illusions people held pre-recession were that owning meant wealth, money, and an ever-increasing investment. Unfortunately, this trend was broken by the unsustainable mortgage portfolios held by banks. Now many previous homeowners and potential homeowners are starting to understand the monumental risks associated with owning property, which could push many potential homeowners into the rental market for a good long time. But the speculated upward pressure in rents is not going to come from prior homeowners.

It will be the masses of young and middle-aged people who moved in with roommates or moved back home. Once the economy starts to bloom, these people will be the primary reason for increased demand for apartments. The roommates will separate and once again become single dwellers and the ones that moved back home will reemerge as renters. The possible influx of renters could bring prosperity to many of the multifamily management companies around Portland.

But I believe many have overlooked the existing renters - the ones not badly effected by the recession who were able to maintain their housing situation. These are the people who still have good credit, haven't gone through bankruptcy, possibly holding a little nest egg whose purchasing power has greatly increased in light of the currently deflated housing prices. These are the future homeowners. These are the people who will be exiting the rental market and moving into the owning market, and there are quite a few of them out there.

This past month saw a 27% increase from the previous month in new-home sales. This statistic is upwardly biased by the tax credit deadline, which is at the end of this month, but what the statistic does tell us is that people are not as scared as many might have believed. And with the banks' purse strings tightened, it seems unlikely that the same disaster will strike again in the near future.